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Industry Analysis: Metal Fabricating
One of the few, shared traits among the Metal Fabricating companies under our review is that they are intermediate producers of hundreds of thousands of materials and components used by a variety of manufacturers, many of which are highly cyclical. End customers reside in the auto, residential and commercial construction, mining, energy, aerospace, general industrial and other sectors.
Broad Economic Exposure
Metal fabricators' sales and earnings performance and prospects vary from company to company, given economic influences, the wide range of markets served, and each industry member's specific area of concentration. Thus, while sweeping generalizations are not as applicable here as they may be to other industries, it can be said that this group's fortune is closely aligned with that of the domestic economy, and to a growing extent, other global economies.
As the U.S. is now largely dependent on the service sector, which accounts for about two-thirds of gross domestic product, general economic measures are not all that helpful. Overall industrial production provides a better reading of the operating health of the "metal benders". The Institute for Supply Management is a good source of relevant statistics. In its monthly reports on business, the Institute issues an index figure, based on surveys with manufacturers, indicating whether the industrial sector is expanding, as indicated by a rating of 50 and above, or contracting, with a rating below 50. The ISM reports lend clarity to prevailing trends.
Key End Markets
On a finer level, it's more important to closely examine conditions faced by key customers. Business prospects may be determined by reviewing statistics surrounding auto production, home construction and renovation, commercial airline travel, global energy consumption, mining activity, infrastructure development, defense, and among other areas, raw material procurement.
When investing in this industry, one should consider each company's degree of diversification and its manufacturing flexibility. While some metal fabricators are limited as to what they can produce and what industries they may serve, others are capable of shifting production among various product lines. The latter can focus on sectors where the demand trends are most favorable. Such companies are usually able to generate sustainable revenue and net-profit growth across all phases of the economic cycle.
Another consideration is the need for vigilance against cost competition, both at home and overseas. This is commonly addressed through ongoing cost-reduction and restructuring initiatives. Too, work-process measures, such as Six Sigma and Lean Manufacturing, are implemented across all areas, from order placement to shipment.
The U.S. market for metal products and components is largely considered mature. Important end users in the automotive and housing industries have very modest opportunity for expansion. Developing countries, however, hold much promise. These nations have sizable populations, and as they industrialize, wealth per capita rises, auguring well for demand.
Generally speaking, companies have strived to diversify operations, being careful not to stray too far from their traditional business. By and large, this has meant expanding operations to other parts of the world. A broad, international reach helps to reduce exposure to any single economic region.
As is the case with many other industries, China and India have had a big impact on the Metal Fabricating group. Indeed, China has emerged as one of the world's key growth engines. As that economy expands, a greater proportion of the population is transitioning from subsistence living to a middle-class, consumer lifestyle. An ever-larger quantity of high-value goods (e.g., automobiles, refrigerators, air conditioners) and services is being consumed.
Aside from tapping increased demand in developing nations, the metal benders are taking advantage of economical, local manufacturing. Costs are lower mainly due to modest wages and attractive tax rates. The amount of business being done outside the U.S. has grown significantly over the years. In some cases, a company's foreign sales account for more than 50% of the total. One potential drawback to this strategy, however, is increased currency risk. When the American dollar is weak, relative to other currencies, bringing overseas profits back home yields a nice premium. Conversely, a strong dollar can weigh on the bottom line.
Most metal fabricators are capital intensive, and maximizing operating leverage is crucial for them. During periods of economic expansion, or high demand, these companies can easily cover fixed costs. In a contraction, however, cost absorption falls, and management has to cut variable costs, where possible, to support margins. Investment in machinery and facility modernization helps to expand capacity and/or improve production efficiency. Capital outlays are financed with a combination of cash, debt and equity, according to the cost of each.
The industry has a history of mergers and acquisitions. Deals are done with the aim of fine tuning product lines, improving operating efficiency and/or boosting long-term growth opportunity. Notwithstanding past consolidation, this sector, having thousands of small private companies, is still rather fragmented. M&A activity is sure to continue to be a factor in this industry for quite some time.